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A small business owner stands in front of cowboy boots in her store

Too Important to Fail: U.S. Small Business Survival During COVID-19

Guest Author: Neeraj Aggarwal

Small businesses are the engine of the U.S. economy and the cornerstone of our communities. Our favorite restaurant, cherished clothing boutique, local movie theater — these are institutions that are incredibly important to our day-to-day lives. Small businesses, which are those with less than 100 employees, represent 98% of businesses in the U.S. and account for 42 million jobs (33% of private sector jobs).

Prior to COVID-19, small businesses added an average of 1.5 million jobs per year. That’s more than three times the number of jobs created by businesses with more than 500 employees. In the poorest 30 counties in the U.S, small businesses account for more than 60% of jobs.

Three Challenges Faced by Small Businesses

Despite significant federal assistance, small businesses have struggled amid COVID-19. While federal stimulus has provided a necessary one-time injection to support struggling small businesses, there are three major challenges that small businesses continue to face in accessing the financing they need to resume and sustain their operations.

1. Lack of Small Dollar Loans (<$50,000)

Forty-four percent of small businesses are seeking a loan of less than $50,000. Despite continuing improvement in credit markets, traditional lending has not closed the gap in small dollar lending because making small dollar loans is expensive. If lenders passed on the true costs of sourcing, underwriting, and managing these loans, it would result in prohibitively high interest rates for borrowers — about a 30% annual interest rate. As a result, most traditional financial institutions, and even newer financial institutions like fin-techs or revenue-based lenders, avoid making loans less than $50,000.

2. Exclusionary or Inflexible Underwriting Criteria & Processes

Many lenders require at least one of the following: a minimum credit score, collateral, co-signer, or personal guarantee. This makes sense for large businesses, but the data show that it has the unintended effect of excluding many small businesses. Banks reject three million small business loan applications annually, and average loan sizes to women-owned businesses are 31% less than male-owned businesses. Minority-owned businesses are three times more likely to be denied credit.

3. Lack of ‘Portability’ Between Small Business Lenders

Small businesses that are successful in receiving and paying off loans with small dollar lenders may hit the lending cap from that lender. If they require more financing, they will have to begin a new process with a new lender, which means building a new relationship and re-establishing credibility.

A Solution: Small Dollar, Flexible Loans for Small Businesses

Over the last 12 months, the foundation has invested $7 million across four institutions to bolster the small business lending ecosystem in Texas. Our investments have focused on three types of institutions: micro-enterprise lenders such as JUST and Grameen America, crowd-lenders such as Kiva, and Community Development Finance Institutions (CDFIs) such as LiftFund.

A graphic showing small business lenders and their placement on a spectrum from loose to tight FICO conditions underwriting and from high to low APR. Institutions in order from loose to tight FICO conditions: micro-enterprise, crowdfuding/crowdlending,  Community Development Finance Institutions, fin-tech lenders, revenue-based lenders, bank loan. Institutions in order from highest to lowest APR: micro-enterprise, crowdfuding/crowdlending,  Community Development Finance Institutions, fin-tech lenders, revenue-based lenders, bank loan. These types require subsidy: micro-enterprise, crowdfunding/crowdlending, Community Development Finance Institutions. These types don't require subsidy: fin-tech lenders, revenue-based lenders, bank loan.

These institutions share the following three traits.

1. An Explicit Program for Small Dollar Lending

JUST, Grameen America, and Kiva make loans starting at $500 for micro-businesses and can provide up to $15,000. CDFIs such as Lift start at $1,500 and can go up to $50,000.

2. Flexible Underwriting Criteria

These institutions represent three different underwriting models that have demonstrated high impact — reaching otherwise underserved business owners — and high repayment rates of more than 90%.

  • Grameen America and JUST serve women only and require borrowers to form ‘lending groups’ with other women — they require no other criteria to qualify for a loan. Through a mechanism of group accountability, women take out loans and receive larger loans as they repay on time.
  • Kiva works with community-based small business hubs that provide technical assistance to small businesses. These hubs help small businesses place their profile on the Kiva website, where businesses can receive a 0% loan from the ‘crowd’.
  • CDFIs typically adopt more traditional underwriting criteria but are more flexible in terms of the credit score, collateral, co-signer, or personal guarantee requirements.

3. Portability for Small Business Borrowers

Over the past 12 months, these institutions have increased their connectivity such that borrowers can now move among the various lenders. For instance, LiftFund and JUST are developing a partnership so that borrowers from JUST who reached the loan cap of $10,000 can get a referral to LiftFund for larger loans up to $50,000. LiftFund partners with major banks so that these borrowers can also be eligible for loans above $50,000. Similarly, borrowers that do not meet LiftFund’s underwriting criteria could be referred to JUST for consideration.

Lessons Learned

The pandemic has exposed the underlying challenges associated with the small business lending ecosystem. It has also shined a spotlight on lenders who successfully use alternative approaches to reach underserved borrowers. Here are three learnings for other funders looking to deepen their impact with small businesses:

  • Portfolio performance is robust. Notwithstanding the challenges of the pandemic, small businesses have proven remarkably resilient. Across our cumulative portfolio of approximately 5,000 Texan small businesses, 98% of repayments remain on track. We made investments in the form of loans and expect to recover more than 90% of our invested capital.
  • Small business lending is a ladder. The goal is for borrowers to obtain the right amount of capital they need at the lowest possible cost. Micro-enterprise, crowdlending, and CDFIs have their limits — we need to ensure that borrowers are setup to graduate to higher dollar, low-cost loans.
  • Trust is the most important currency that a lender can have. The hallmark of a good lender is the trust they can develop within the small business community. Different institutions build trust in different ways: creating a borrower community, providing technical assistance / financial coaching, adopting flexible underwriting, offering tailored financial products, and more. Trust is ultimately how lending institutions attract the best clients and maintain strong repayment rates.

As small businesses continue to navigate the effects of the pandemic and serve their communities, funders and investors must keep showing up with essential resources and flexibility. This support safeguards millions of jobs, improves the economy, and protects the institutions that families rely on. I’m grateful for all our partners dedicated to walking alongside small businesses during the pandemic, and beyond.

Pictured at top: Aurora, a Grameen America microloan recipient in Houston, TX. Photo by Caitlin Feltman Photography.